The Difference Between 506(c) Offerings and Crowdfunding

Regulations set by the Security and Exchange Commission (SEC) have gone under a few changes in the past couple years. These changes were made as a result of the Jumpstart Our Business Startups Act, or the JOBS Act. The JOBS Act was created to reduce barrier to capital formation” for small companies. It is meant to help companies attract investors more easily through the establishment of Rule 506(c) and push to regulate equity crowdfunding.

Companies were exempt from registering their transactions as long as there was no public offering involved prior to the JOBS Act. Rule 506(c) gets rid of the prohibition of general solicitation as long as investors resulting from that solicitation follow a few rules. This is different than crowdfunding, and here we will explain how and why.

The Basic Framework

Both 506(c) offerings and crowdfunding make it easier for companies to tap into a diverse network of investors and both harness the potential of new technologies to raise capital quickly and cheaply. However, there are some crucial differences between the two. A basic guideline is that in most cases, a 506(c) offering has fewer restrictions than crowdfunding, except it comes to who can invest, where the rules are stricter for a 506(c).

Who Can Invest?

This is the one area where crowdfunding offers a more flexible opportunity to cast a wide net. 506(c) offerings must be made only by accredited investors, whereas crowdfunding ventures are free to accept backing from nonaccredited investors as well.

Rule 506(c) investors must be verified as accredited investors. Investors are often reluctant to provide sensitive financial information about themselves to a company they are agreeing to support, so they go with a third-party service to get past the verification hurdle.

How Much Capital Can You Raise?

While 506(c) offerings have no limit on their potential capital raise, crowd funders are restricted to a $1 million cap each year. This might not be useful for a business that needs a lot of capital up front to get going.

Can You Advertise?

While 506(c) offerings are marketed and advertised freely now, the rules overseeing crowdfunding solicitation are more restrictive. General advertising is severely limited and primary disclosure has to occur on an established “funding portal” meaning one of the crowdfunding websites we have seen on social media.

What is Legal?

Crowdfunding is somewhat legal and 506(c) is legal. Only 11 states have legalized equity crowdfunding for business and those states do not allow the use of social media to attract investors. Equity crowdfunding is not yet legal although there is a suggested framework in place.

What is Right for Your Company?

A range of factors come into play when deciding whether to go with 506(c) offerings or crowdfunding and they are as follows:

• The size and scope of your company: Is $1M enough for you, or do you need more than that to get started? If you need more money up front, you should go with the 506(c) offerings. If your financial needs are less at the beginning, consider crowdfunding.
• Your product or service and its audience: Your audience also includes your potential investors. Are they likely to have the financial security to be accredited? If so, go with 506(c). If you are looking for a wider variety of investors, crowdfunding may be more appealing.
• Your timeline: Do you need capital now, which would require you to use Rule 506(c), or can you wait as money trickles in?
• Legality: Remember that crowdfunding still involves some legal pitfalls regarding how much can be invested. Accredited investors have a sense of the risk they are taking when they invest, whereas small amount investors on a crowdfunding site may not. Consider the potential for backlash in your plan going forward and remember to play it safe and consult your securities attorney.